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Cash vs. Accrual Accounting: Key Differences

You might be wondering what the difference even is! Our guide is here to help clear up some of those questions.

If you’re a new small business, you may be faced with the dilemma of choosing a basis of accounting: cash or accrual? Making this decision can affect how much you understand your business.

Before we get to that, let’s start at the basics.

Knowing the difference between cash and accrual is completely down to timing. Let’s imagine your business sells accessories for pets. You receive an online order on a Friday evening for a bulk amount of dog food.

How you choose to record this transaction reflects whether you use the cash or accrual accounting method.

If you were to record the financial transaction only when the transaction has been processed and money appears in your account, you would be using a cash basis accounting method. This is because you are recording financial transactions only once money has changed hands. This would be the same if you were buying stock or supplies; if the transaction is recorded when the money leaves your account, it’s the cash basis method.

person paying through his phone

On the other hand, let’s say you recorded the transaction when you received a bill for the goods but had not yet paid. This would be the accrual accounting method. With this method, financial records are made when bills are received or invoices are sent, not when money changes hands. You would also record these kind of transactions as accounts payable – denoting your obligation to fulfil a payment – or as accounts receivable – denoting that you will receive a payment for a service or goods. This goes hand-in-hand with the double-entry bookkeeping method.

Now you know the difference between the two, you might be asking why you would choose one over the other.

Benefits to Cash Basis Accounting

Cash basis accounting is perfect for a new business. It’s simple to maintain and doesn’t require extensive information. To know how your business is functioning, all you need to do is look at the balance of your account. It’s also much easier to understand how much tax you need to pay.

This might sound great, but it’s not really practical for business growth. It can save you time and money initially but it can also give you a bit of a headache. Cash basis accounting doesn’t really give you an accurate idea of how your business is performing.

Imagine your business account for the pet shop shows that you have a positive balance. It could be that your balance is only positive because you haven’t yet processed any expenses or payments to suppliers. In that case, how would you know how much money your business really has?

Let’s take it a step further. You see that initial positive balance and, as a result, decide to purchase more stock. The next day, all your expenses are processed and more money than you thought is taken out of your account. As a result, you find your balance is in the negative and you’ve been charged an overdraft fee by your bank!

In short, cash basis accounting only really accounts for day-to-day business and doesn’t give you an idea of the long-term health of the business. As such, it’s much harder to make business decisions!

Benefits to Accrual Basis Accounting

Unlike cash basis accounting, with accrual basis accounting you get a much better picture of your business’ activity. You have a better idea of accounts receivable and accounts payable. That means you know where you have money coming in and going out.

As a result, you can make better informed business decisions based on the more accurate financial data you have recorded.

Having more detailed and accurate bookkeepers records also means you’re in a better position to raise capital. A bank is much more likely to lend you money if you can accurately represent and forecast the financial position of your company. This is only really possible with accrual basis accounting.

The downside? Accrual basis accounting is time-consuming and requires a lot of work. It can take a considerable amount of time to keep track of bills and invoices. As well as this, when it’s time to record your taxable income you may have accounts receivable to take into account. In this case you might have to pay tax on invoices that haven’t been paid yet!

A solution to this roadblock, however, is to hire a professional bookkeeper. Check out what Count can do here!

Making your decision

Managing your financial records accurately can be make or break for a growing business. Financial records can help you track and monitor the progress of your business. But this can only really be done with an accrual basis accounting system.

By recording invoices and bills you can get a much better understanding of how your business functions and, most importantly, how it will function in the future.

Unless you’re a brand-new business, accrual basis accounting is probably the best way to go!

If you need more information on managing your financial records, check out the rest of our guides!

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